So Who Needs Wall Street?

Barry Silbert of SecondMarket is innovating around America's broken public capital markets.

By

Mary Kissel

October 29, 2011

'No entrepreneurs I know aspire to be a public-company CEO anymore."

If that seems like a startling claim, it's all the more so coming from a bright-faced 35-year-old sitting a stone's throw from Merrill Lynch's famous charging bull. But Barry Silbert can back up his words because he's making money on them. He's the founder and CEO of SecondMarket, an online trading platform that pairs buyers and sellers of such financial assets as mortgage-backed securities and especially the stock of companies that haven't gone public.

Depending on your point of view, he is either saving capitalism from financial regulators or trying to evade them. Either way, he's an example of an entrepreneur finding a way to help America's other beleaguered capitalists find capital.

On a recent day in his Wall Street office, he starts by recounting the challenges faced by America's capital markets. Settling into an armchair, he starts with the advent of online brokers in the 1990s, which eliminated the "hundreds of thousands" of human brokers who were "focusing on not just the GEs of the world, but helping their customers identify small-cap stocks."

Then stocks went from trading in fractions to decimals, which shaved returns for firms dramatically and reduced their ability to research and market small-cap stocks. Add high-frequency trading, which led to unwanted stock volatility.

Then there are the regulatory burdens. The 2002 Sarbanes-Oxley law "made it more expensive to be a public company," mainly by imposing millions of dollars of compliance costs. And Eliot Spitzer's settlement with investment banks more or less ended research on small-cap stocks by forbidding banks to use investment-banking revenues to fund research.

Now the IPO market is limping, especially for small companies. According to a report this month from the IPO Task Force (a group of venture capitalists, bankers, lawyers and other interested parties), nearly 2,000 "venture-backed, emerging-growth companies" went public from 1991 to 2000. From 2001 to 2010, only 477 did.

Such problems have created Mr. Silbert's opportunity. He didn't grow up working in the hurly-burly of financial markets but was raised in a middle-class home in Gaithersburg, Md., mostly by his mother. His father died when he was 10. Mr. Silbert worked odd jobs from the time he was a teenager but was always drawn to trading, registering as a broker at 17.

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Terry Shoffner

Working for a restructuring firm, he recalls, he encountered "situations as a banker where there were illiquid assets, whether it was private-company stock or otherwise. I was always shocked there was no centralized place to go to, an eBay-type platform." So he quit the firm and put together a business plan.

"It was like a Wall Street version of a Silicon Valley garage start-up," says Mr. Silbert. "Our technology was a telephone and an Excel spreadsheet. But over time, we were able to develop such a deep pool of buyers and such a large amount of assets for sale that we had to really start investing in technology to make the process more scalable, more efficient."

In 2007, a former Facebook employee approached SecondMarket looking to sell stock options, so the company surveyed its clients. "It was interesting to us to see these institutions were willing to buy the stock without having access to management, without having information," Mr. Silbert recalls. "Microsoft had done their deal, which valued [Facebook] at $15 billion. It was pretty widely well-known where the company was issuing options, where the strike price was, which was one way to estimate value. So we did a few of these transactions."

Other companies and investors soon wanted to do similar trades. "So we said 'Okay, what's happening?'" Mr. Silbert says. "We went out to the venture-capital community, particularly up and down Sand Hill Road, saying 'Hey guys, what do you think? Is there a need for a private-company marketplace?' And the reaction was, it was funny, it was almost universally: 'There's no need for it, you'll never be successful, the market is cyclical, the IPO markets will come roaring back.'" Mr. Silbert pressed ahead.

His business boomed as public markets faltered. He took risks, making markets in unusual securities—like the state of California's individual registered warrants, issued during a 2009 budget crisis—and he received venture capital from FirstMark Capital, Hong Kong tycoon Li Ka-shing, and one of Singapore's state-owned investment funds. In 2010, SecondMarket traded $10 billion in assets, up from $2.5 billion in 2009 and $1 billion in 2008. (The company won't forecast this year's results.) Last month, it listed its own shares on its platform and they sold out quickly. "We have 140 employees, 20 open spots right now, hiring as fast as we can."

Mr. Silbert says he's not building a business by evading regulators, although there's always a risk that they will still come after him. SecondMarket is registered with the Securities and Exchange Commission as an "alternative trading system," its compliance staff communicates regularly with its Washington minders, and Mr. Silbert hired a former SEC lawyer to be his general counsel. "I spend a lot of time with the SEC, helping them kind of think through . . . how do we create the next new growth market for our country?"

SecondMarket requires companies to provide "audited financials and risk factors" to potential investors. "That's not required under the SEC rules," he says. "We don't want to see fraudulent companies on SecondMarket. We don't want to see people, you know, making investment decisions without being well-informed. That's bad for us as a marketplace."

So what is his comparative advantage over Wall Street? Well, he says, investment banks "keep the buyer and the seller separate and they control that information." SecondMarket is a platform that aims to "connect all the world's buyers and sellers—to essentially disintermediate anyone on Wall Street that does not add value." It allows companies far more flexibility to choose when their shares trade and among which investors, and its website helps companies build networks of "trusted" counterparties. SecondMarket doesn't disclose the identity of its clients to outside parties, however.

Which raises a broader question: Is Mr. Silbert creating a market open only to the sophisticated, a club that shuts out ordinary Americans? "I'm happy you asked that," Mr. Silbert says, adding that mutual funds like T. Rowe Price invest in SecondMarket's offerings and are "open to retail investors." And Mr. Silbert has an even bigger idea: to lobby the SEC to change its definition of "sophisticated investor."

"The SEC rules right now use income or net worth as the way to measure sophistication," he says. There are several tests. One defines "sophisticated" as having a net worth of more than $1 million, excluding the investor's home. But Mr. Silbert says "there are plenty of wealthy individuals who are not sophisticated in financial investing who maybe should not be investing." So he proposes an SEC-administered "financial literacy test" that would allow those who pass it to participate in SecondMarket and "any type of investment that is not an SEC-registered investment product."

Does Mr. Silbert really support fixes to the public markets, given SecondMarket's private-market business niche? "We too want to see a robust public market," he replies, because "for larger companies in particular, you'll never be able to find a deeper pool of liquidity." I press him on the point. "Let's make sure we at least have a private market that's robust and functioning and safe and trusted, so that either it's going to be supportive of a public market, or, worst-case scenario, if the public market is forever broken for smaller-cap companies, we have an alternative," he argues.

To that end, Mr. Silbert is lobbying Congress to change what he calls "outdated" rules that "have had a negative effect on private companies' ability to raise capital and compensate their employees." Among them: a 1960s-era rule that limits private companies to 500 shareholders and a prohibition on those companies soliciting broadly for investors. "Car companies can advertise on TV to 15-year-olds, and drug companies can advertise drugs to people who don't have a prescription," but start-ups can't advertise to potential investors, Mr. Silbert says.

His efforts may be paying off. On Wednesday, the House Financial Services Committee passed bills that would eliminate the advertising ban, raise the investor threshold to 1,000 from 500, and remove restrictions on so-called crowd-funding (when entrepreneurs raise money from relatives or others who aren't SEC-accredited, within certain limits).

So what will America's capital markets look like a decade from now? "There's not going to be a concept of public versus private," Mr. Silbert says. "What there's going to be is companies trading on different markets, and those markets have different rules." That vision assumes politicians will keep punishing America's public markets, and on present course it's hard to bet against him.

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